What is going to happen to the Italian bond spread?
I expect Italy’s spreads to remain near their current, extremely high levels in coming months. And given the loss of confidence in the eurozone’s and Italy’s ability to contain the crisis, European Central Bank (ECB) intervention—or the expectation of its intervention—is almost certainly the only thing stopping the Italian bond spreads from reaching even higher levels.
I expect that the ECB will ensure that Italian yields do not go much higher because if they did, not only Italy’s but also the euro’s future would be put at very serious risk. Nor will spreads move much lower soon: it would be difficult for Italy to quickly regain the confidence of markets given all the political uncertainties and the strong possibility that its economy will go into a credit-crunch-induced recession. It is unlikely that the ECB will intervene to lower Italian bond yields significantly because that would take the heat off Italy’s politicians to support the new government of Mario Monti as it attempts to enact far-reaching reforms.
I expect that the ECB will ensure that Italian yields do not go much higher because if they did, not only Italy’s but also the euro’s future would be put at very serious risk. Nor will spreads move much lower soon: it would be difficult for Italy to quickly regain the confidence of markets given all the political uncertainties and the strong possibility that its economy will go into a credit-crunch-induced recession. It is unlikely that the ECB will intervene to lower Italian bond yields significantly because that would take the heat off Italy’s politicians to support the new government of Mario Monti as it attempts to enact far-reaching reforms.
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Interest rates on Italian ten-year bonds have already hit 7 percent. That means, with Italy’s high debt, low long-term growth rate, and inflation, the country must run a primary surplus of around 5 percent on a sustained basis in order to keep its debt/GDP level from spinning out of control. Such sustained budget surpluses have rarely been seen and appear highly implausible, especially given the Italian political context. So, though Italy can afford them over a short period, interest rates at this level cannot persist indefinitely.
